Bombay High Court on Disallowance under Section 14A of the Income Tax Act and the Binding Nature of Judicial Precedents

[The following guest post is contributed by Kruthika Prakash, Advocate, Madras High
Court]

The
Bombay High Court has recently issued an important judgment in HDFC Bank v. DCIT [2016] 67 taxmann.com 42 (Bom.). The High Court has dealt
with the issue of applicability of section 14A of the Income Tax Act [hereinafter
“the Act”] in respect of the tax-free income earned on investments in case a
party possesses interest-free funds in excess of the investments made in tax-free
securities. Furthermore, the Court passed strictures against the Tribunal for
disregarding decisions of the jurisdictional High Court and in this process
revisited the law on the binding nature of judicial precedents.

To
briefly recapitulate the facts: The assesse, while filing returns for the AY
2008-2009, declared a tax exempt income from investment in securities and
treated the same as stock-in-trade. It is pertinent to note that during the
same assessment year the assessee had paid interest on borrowed funds and
treated the same as expenditure. The assessee did not disallow any expenditure
on interest earned on tax free securities. However, both the Assessing officer
and the CIT-Appeals disallowed a sum of Rs. 3.39 crores as per section 14A read
with Rule 8D on the ground that the assessee did not provide evidence that the
investment was made from interest-free funds.

Being
aggrieved, the assessee appealed to the Appellate Tribunal. The assessee raised
two issues. First, that disallowance
under section 14A could not be made in view of assessee’s own case in CIT v.
HDFC [366 ITR 505] as it possessed interest-free funds which were more than
the tax-free investments. Secondly,
that the tax free securities were held by it as its stock-in-trade and hence no
disallowance of any expenditure under Section 14A of the Act could be made in
view of decision of the Bombay High Court in CIT v. India Advantages Securities
Ltd. [ITA 1131/13 decided on 30 April 2014]. The Tribunal rejected the
assessee’s contentions relying on another decision of the Bombay High Court in Godrej and Boyce Manufacturing v. Co. Ltd. v. Deputy Commissioner of Income Tax, [328
ITR 81]. Against the order of the Tribunal, the assessee filed a writ petition.

High Court Decision: The High Court noted that the issue on
disallowance of interest expenditure in case assessee makes a tax-free
investment when it has both interest-free funds and interest bearing funds is
covered by judgment in CIT v. HDFC 366 ITR 505 [HDFC Bank Ltd.]. In CIT v. HDFC, the Bombay High Court had held
that no disallowance for interest
could be made based on the reasoning that if the assessee has more interest
free funds than the tax free investments, then a presumption would arise that
tax free investments would be out of the interest-free funds. The
Bombay High Court relied upon the decision in CIT v. Reliance Utilities and
Power Ltd 313 ITR 340 (Bom).

Furthermore,
the Court noted that the decision in Godrej
and Boyce Manufacturing Co. Ltd. does not provide any ruling on the issue
of presumption and restores the entire issue of determining whether the
assessee had incurred any expenditure in relation to the earning of tax free income
to the Assessing Officer. In Godrej and
Boyce Manufacturing Co. Ltd, the court upheld the validity of section 14A
of the Act and Rule 8D and the Rules. Taking note of this, the Bombay High Court
in HDFC v. DCIT clarifies that there is no conflict between the decisions of
the Bombay High Court in Godrej and Boyce
Manufacturing Co. Ltd. and HDFC Bank
Ltd. The analysis of this issue is in Para
13,

The test to
decide whether or not two decisions are in conflict with each other is to first
determine the ratio of both the cases and if the ratio in both the cases are in
conflict with each other, then alone, can it be said that the two decisions are in
conflict. We find that no such exercise has been done. If it was done, the
Tribunal would have noted that this Court in Godrej & Boyce Mfg. Co. Ltd. has not decided the issue of
applicability of Reliance Utilities &
Power Ltd. inasmuch as it has restored the entire issue to the Assessing
officer after upholding the constitutional validity of Section 14A of the Act.

On
the ancillary issue of the investment in securities being treated as stock-in
trade, the Bombay High Court again agreed with the assessee that the issue is
covered by the decision of the Bombay High Court in CIT v. India Advantages
Securities Ltd.

Binding Nature of Judicial
Precedents

Incidents
of Tribunals and lower courts disregarding binding decisions of jurisdictional
High Courts raise serious concerns. Taking note of the same in this case, the
High Court assumed jurisdiction under Article 227 of the Constitution of India.
It noted that the Tribunal had committed a patent error by disregarding binding
decisions of the jurisdictional court and passed strictures against the Tribunal.
The Court referred to several important cases including Union of India v. Raghuvir
Singh 1989 (2) SCC 754 and Collector
of Central Excise v. Dunlop India
Ltd. 154 ITR 172, revisiting the law on the binding nature of judicial
precedents. The Court summarised the position in Para 22,

Once there is a
binding decision of this Court, the same continues to be binding on all
authorities within the State till such time as it stayed and / or set aside by
the Apex Court or this very Court takes a different view on an identical
factual matrix or larger bench of this Court takes a view different from the
one already taken.

It
is pertinent to note this incident of the Tribunal disregarding a High Court
order and the High Court disapproving of such a practice is not a one-off
incident. The Gujarat High Court in Commissioner
of Income Tax v. G. Dalabhai &
Co. [1997 226 ITR 922 Guj] notes a statement of the Income Tax officer in
his Assessment Order. The shocking statement being – “With due respect to the
decision of the Gujarat High Court, I do not follow the same”. This indicates a
clear disregard towards the principle of stare
decisis Further, in National Textile
Corporation Ltd. (M.P.) v.
Commissioner of Income Tax [2008]171TAXMAN339(MP), the Madhya Pradesh High
Court held the Tribunal has no jurisdiction to find fault with the decision of
a jurisdictional High Court so as to avoid its binding effect.

In
conclusion, it may be said that the clarificatory nature of this decision adds
to the existing jurisprudence on the issue of disallowance of expenditure
relating to tax-free investment when the investor has both interest-free funds
and interest bearing funds. It is to be hoped that the strictures passed by the
Bombay High Court would create a sense of responsibility in lower courts and
tribunals to ensure uniformity. Otherwise, the very essence of stare decisis will be uprooted and it would
lead to an atmosphere of uncertainty and lack of confidence in the judicial
system. In sum, it may be aptly said:

This conflict
between the High Court and the Tribunals and other subordinate courts involves
more than a mere dispute among forums as to proper statutory constructions. It
exposes a jurisprudentially unhealthy situation in which the law is unevenly
enforced and in which there is no finality until the Supreme Court speaks. [Modifications Mine – Inspired by a quote
made in the Duke Law Journal- Note, Controversy Between the Tax Court and
Courts of Appeals: Is the Tax Court Bound by the Precedent of its Reviewing
Court?, 7 Duke L.J. 45, 50-51 (1957)]

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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